A Proposed Mapping to Key Article Distinctions - Framework based on MSCI Client Feedback
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A Proposed Mapping to Key Article 6 / 8 / 9 Distinctions - Framework based on MSCI Client Feedback OVERVIEW AND ANALYSIS OF MSCI ESG INDEXES BASED ON A SET OF ASSUMPTIONS DISCUSSED WITH INVESTORS March 2021 © 2021 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document. Information Classification: GENERAL
Introduction • As part of the EU Financing Sustainable Growth Action Plan, the EU Sustainable Finance Disclosure Regulation (SFDR) was established to lay down harmonized rules for financial market participants and financial advisers on transparency with regard to the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes and the provision of sustainability‐related information with respect to financial products. • Apart from the disclosure requirements, funds promoted as ESG are required to classify as being Article 8 or 9 products, depending on whether they meet the requirements for either classification, with Article 9 taking on more restrictive criteria. • This deck lays out a proposed mapping to key Article 6, 8, and 9 distinctions, which includes an overview of select MSCI ESG Indexes and how they compare against a set of assumptions based on MSCI analysis and inputs from industry participants who were involved in MSCI’s client engagement initiatives. This deck has been updated to reflect the Joint ESA’s Final Report on the draft Regulatory Technical Standards (RTS) regarding the disclosure requirements of the SFDR dated February 2, 2021. Information Classification: GENERAL
Disclaimer The information found on this deck is provided to help guide thinking around the approach for Article 6, 8 and 9 products under the EU Sustainable Finance Disclosure Regulation (SFDR). The information is provided “as is” and does not constitute legal advice or binding interpretations of the SFDR. MSCI’s proposed approach to the key SFDR distinctions are based on assumptions and client feedback as explained in this deck. Any designations of your Article 6, 8, and/or 9 products and interpretations of key SFDR distinctions/terms are the responsibility of financial market participants and should be discussed with your own legal counsel and your national competent authority as needed.. Information Classification: GENERAL
Sustainable Finance Disclosure Regulation (SFDR) Entity Level* Product Level* Financial market participants** (FMPs) must disclose: Financial advisors must disclose: FMPs must disclose: On their websites, On their websites, information on integration of On their website, information on • Information on the integration of sustainability risks in their sustainability risks (including principal adverse products pursuing sustainable investment decision-making process (and if not relevant, why) sustainability impacts) in their investment advice or objectives (Article 9 products) or insurance advice on their websites (and if not promoting E&S characteristics (Article 8 • When “principal adverse sustainability impacts” are being relevant, why) products) considered, statements with their due diligence policies (and if not relevant, why) (Compulsory for firms with 500+ employees) In pre-contractual disclosures In periodic reports (e.g., annual reports) (and if not relevant, why): information how sustainable objectives • Principal adverse impacts statement (Annex I) or E&S characteristics are met • How sustainability risks are integrated into their In pre-contractual disclosures (and if not relevant, why): investment or insurance advice (Also note requirements + separate • Manner in which sustainability risks are integrated into their • The result of the assessment of the likely impacts timing on principal adverse investment decisions of sustainability risks on the returns of the financial sustainability impacts) • Likely impacts of sustainability risks on the returns of the products financial products 9 December 2019 1 September 2020 February 2021 Q2-Q3 2021 or later Between March 2021 & Regulation published Close of European Supervisory Final report on draft RTS Final DAs on the RTS expected to be June 2023 in the Official Journal Authorities (ESAs) consultation on draft published by ESAs adopted by the Commission and compliance due regulatory technical standards (RTS) published in the OJ (likely in Q2-Q3 2021) This is provided for informational purposes only and does not constitute legal advice. Timetables may change according to the EU legislative process. *Principles-based disclosures were due starting March 10, 2021; prescriptive disclosures (e.g. principal adverse impact statement/product templates) as well as the reference period starts January 1, 2022 with the first reporting due in June 2023 **e.g. AIFMs; investment firms providing portfolio management; institutions for occupational retirement provision; and UCITS management companies. 4 Information Classification: GENERAL
Rationale for the Framework • Following the publication of the SFDR draft regulatory technical standards (RTS), MSCI conducted a series of client engagement initiatives: – Four workshops in August 2020 attended by 66 clients mostly based in EMEA. – One-on-one discussions with key ESG / ESG index clients in the second half of 2020 – Online survey sent to 900 clients • Key Highlights: – Clients expressed strong interest for a framework to help them classify their ESG funds – Clients consider Article 8 as funds integrating ESG considerations and being more focused on financial materiality, while Article 9 funds are seen as more focused on sustainable economic activities/impact and/or aim to reduce carbon emissions in line with the Paris Agreement – There was a consensus on using proxies for defining good governance practices, as well as on using UNGC or norms-based exclusions as a minimum prerequisite. • Based on the multiple client engagement efforts, we derived a set of assumptions / proxies used to measure MSCI ESG Indexes against key distinguishing features of Article 8 and 9 products. • We have further modified the framework to reflect the Joint ESA’s Final Report on the draft RTS dated February 2, 2021. Information Classification: GENERAL
What are Article 8 and Article 9 products as per SFDR? Article 8 Article 9 • Promotes environmental or social • Must have a sustainable investment objective characteristics, or a combination o Economic activities that contribute to an environmental objective ▪ Key resource efficiency indicators (use of energy, renewable energy, raw materials, water and land, production of waste, GHG emissions, impact on biodiversity and circular economy) o (or) Economic activities that contribute to a social objective ▪ Tackle inequality or foster social cohesion ▪ Social integration and labor relations • Must have good governance practices ▪ Investment in human capital or economically or socially (sound management structures, employee disadvantaged communities relations, staff remuneration, tax compliance) o DNSH principle (OECD, UNGPBHR, ILO, IBHR) AND principal adverse impact indicators (14+) to be taken into account o Follow good governance practices, in particular with respect to sound management structures, employee relations, staff remuneration, tax compliance Source: https://www.esma.europa.eu/press-news/esma-news/esas-consult-environmental-social-and-governance-disclosure-rules 6 Information Classification: GENERAL
Article 8 Key Distinctions POST-ENGAGEMENT INTERPRETATION OF ENVIRONMENTAL OR SOCIAL CHARACTERISTICS + GOOD GOVERNANCE PRACTICES Information Classification: GENERAL
Article 8 Product Key Distinctions based on client feedback Environmental Characteristics Depending on the index objective, measurement varies†. Examples: Climate-based exclusions Child labor score (or) Social Characteristics ESG ratings or score † For exclusions-based approaches, proven material rate of exclusion is necessary Should have at minimum: Good Governance Practices Overall ESG Controversy Information Classification: GENERAL 8
Background on MSCI ESG Indexes: environmental and social data inputs MSCI ESG Indexes use MSCI ESG Research definitions and data sets to identify positive and negative contribution to environmental and social issues through products and services, as well as to select and/or exclude based on their contribution through operations. SCREENING ESG CONTROVERSIES ESG RATINGS ENVIRONMENT SOCIAL Thermal Coal Tobacco Mining Controversial O&G Extraction Weapons Fossil Fuel Civilian Firearms Reserves Thermal Coal GMO Power Adult Oil & Gas Power Entertainment Palm Oil Gambling Other Other Information Classification: GENERAL 9
Examples of MSCI ESG Indexes using environmental or social data inputs Some MSCI ESG Indexes were created with specific Environmental or Social themes, while many others take on a broader approach to incorporate combined Environmental (E) and Social (S) or ESG considerations. Low Carbon Leaders Women’s Leadership SRI Low Carbon Target Japan Empowering Women ESG Leaders Carbon and Potential Emissions Gender Diversity ESG Focus ESG Universal Climate Change ESG Screened Climate Transition Benchmark ESG Ratings Low Carbon Transition Information Classification: GENERAL 10
Background on MSCI ESG Indexes: addressing governance risks • MSCI ESG Indexes, unless focused on specific themes, generally address both the Reduce downside (e.g., headline risks) and upside Downside (e.g., ESG best-in-class) to provide a holistic ESG approach. – Reduction of downside risks is done by excluding worst offenders based on MSCI ESG Controversies, or securities assessed as having Red Flags (Very Severe / Score of 0); as well as based on MSCI ESG Ratings, or securities rated CCCs. – Maximizing upside is done by selecting top Maximize 25% or 50% by sector using MSCI ESG Ratings Upside data, or by tilting weights in favor of better ESG performers in terms of their industry- specific ESG risks. Information Classification: GENERAL 11
Good Governance Practices Proxy based on client feedback ESG CONTROVERSIES ESG RATINGS Key areas of good SOCIAL PILLAR GOVERNANCE Board HUMAN RIGHTS Corporate Pay governance LABOR RIGHTS & AND COMMUNITY CUSTOMERS GOVERNANCE IMPACT SUPPLY CHAIN Governance Ownership Accounting practices Impact on Local Communities Child Labor Product Safety & Quality Bribery & Fraud Business Ethics • Sound Human Rights Collective Anticompetitive Controversial Corporate Anti-competitive Practices Bargaining & Corruption & Instability management Concerns Unions Practices Investments Behavior Financial System Instability Tax Transparency structures Civil Liberties Discrimination & Workforce Customer Relations Governance Structures Diversity Labor Management • Employee relations Labor Human Health & Safety Marketing & Human Capital Development • Staff remuneration Other Management Relations Advertising Other Capital Supply Chain Labor Standards • Tax compliance Supply Chain Labor Standards Privacy & Data Security Not covered Depending on industries’ material by UNGC risks, Labor Management or HCD Health & Safety Other screen may not be incorporated Other Information Classification: GENERAL
Article 9 Key Distinctions POST-ENGAGEMENT INTERPRETATION OF SUSTAINABLE INVESTMENT OBJECTIVE Information Classification: GENERAL
Article 9 Product Key Distinctions based on client feedback Depending on the index objective, Environmental Objective measurement varies but should be in line with themes consistent with Article 2(17) and Article 9(3): Environmental Impact (or) Social Objective Paris Agreement Alignment Social Impact Should have at minimum: Good Governance Practices Overall ESG Controversy Information Classification: GENERAL 14
Interpreting Sustainable Investment Objective based on client feedback Article 2(17): ‘sustainable investment’ means an investment in an economic activity that contributes to an environmental objective, as measured, for Since the definition is currently not example, by key resource efficiency indicators on the use of linked to the EU Taxonomy, a potential energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or approach is to use metrics to on its impact on biodiversity and the circular economy, or indicatively provide economic activities an investment in an economic activity that that contribute to an environmental or contributes to a social objective, in particular an social objective that capture investment that contributes to tackling inequality or that conceptually similar key resource fosters social cohesion, social integration and labour indicators or social themes relations, or an investment in human capital or economically or socially disadvantaged communities, provided that such investments do not significantly harm any of Controversies* to represent DNSH those objectives and that the investee companies follow good governance practices, in particular with Proxy used to capture conceptually respect to sound management structures, employee relations, remuneration of staff and tax compliance; similar good governance practices * In line with MSCI ESG Research’s EU Taxonomy Screening Guide Information Classification: GENERAL
Interpreting Sustainable Investment Objective based on client feedback Article 9(3): Where a financial product has a reduction in Although sustainable investment carbon emissions as its objective, the information to objective specifies “key economic be disclosed pursuant to Article 6(1) and (3) shall activities”, it also specifies that Paris- include the objective of low carbon emission aligned carbon emissions reduction as exposure in view of achieving the long‐ term global one of the objectives that would meet warming objectives of the Paris Agreement. Article 9 requirements. By way of derogation from paragraph 2 of this Article, where no EU Climate Transition Benchmark or EU Proof of Paris‐aligned Benchmark in accordance with Regulation (EU) 2016/1011 of the European Parliament and of the concept: Council (20) is available, the information referred to in MSCI Article 6 shall include a detailed explanation of how the Climate continued effort of attaining the objective of reducing Paris carbon emissions is ensured in view of achieving the Aligned long‐term global warming objectives of the Paris Agreement. Information Classification: GENERAL
Sustainable Investment: Environmental Objective Proxy based on client feedback SUSTAINABLE IMPACT METRICS Economic activities as measured by key resource efficiency indicators • Use of energy • Renewable energy • Raw materials • Water and land • Production of waste • GHG Emissions • Impact on biodiversity and circular economy Examples of indexes that aim to meet similar environmental objectives: ACWI Sustainable Impact, Global Environment, Climate Paris Aligned Information Classification: GENERAL
Sustainable Investment: Social Objective Proxy based on client feedback SUSTAINABLE IMPACT METRICS Economic activities that contribute to key social themes • Tackle inequality or foster social cohesion • Social integration and labor relations • Investment in human capital or economically or socially disadvantaged communities Examples of indexes that aim to meet similar social objectives: ACWI Sustainable Impact Information Classification: GENERAL
Sustainable Investment: Do No Significant Harm Proxy based on client feedback • While the SFDR references Do No Significant Harm Principle, there EXCERPT FROM THE EU is no definition yet. To arrive at a TAXONOMY SCREENING GUIDE: proxy, we follow MSCI ESG Very Severe (Red Flag) and Severe structural (Orange Research’s EU Taxonomy Flag) environmental controversies based on the MSCI ESG Screening Guide, which uses Red Controversy Methodology present a clear indication of and Orange Flags for companies’ violation of standards and norms with significant adverse impact on the environment. Environment Controversies. Every controversy is examined based on the nature of • Similarly, because Sustainable impact (minimal to very serious harm), scale of impact Investment includes social (low to extremely widespread), extenuating and exacerbating circumstances, and structural or objectives, we follow the same idiosyncratic nature of the case. principle but use Red and Orange The overall assessment is represented in a form of a Flags for Social Controversies if score (0 representing involvement in Very Severe cases, the methodology refers to a 10 indicating no involvement in controversies) and a social theme or issue. corresponding flag (Red, Orange, yellow, and Green). Information Classification: GENERAL 19
MSCI ESG Indexes vis-à-vis the Principal Adverse Sustainability Impact (PASI) Adverse Sustainability Indicator Most MSCI ESG indexes already incorporate GHG emissions one or more PASI metrics, albeit with nuances Carbon footprint in metric definitions and/or calculations. They GHG intensity are incorporated either comprehensively or Exposure to companies active in the fossil fuel sector partially, and either as a direct input or indirectly Share of non-renewable energy consumption and production through the ESG Ratings framework. However, given that there is no further guidance in ESA’s Energy consumption intensity per high impact climate sector Final Report on the draft RTS, MSCI cannot Activities negatively affecting biodiversity-sensitive areas determine the extent of incorporation needed or Emissions to water calculate any minimum threshold for reduction Hazardous waste ratio or improvement, from which to form the basis Violations of UNGC principles and OECD Guidelines for Multinational Enterprises of potential methodological changes. Lack of processes and compliance mechanisms to monitor compliance with To illustrate how frequently used ESG factors or UNGC principles and OECD Guidelines for Multinational Enterprises screens provided by MSCI ESG Research and Unadjusted gender pay gap applied as described in MSCI ESG index Board gender diversity methodologies may align to facets of PASI metrics, an indicative mapping is available to clients through Exposure to controversial weapons (anti-personnel mines, cluster munitions, chemical weapons and biological weapons) the MSCI Client Support site. Note: Highlighted are examples of PASI metrics that MSCI ESG indexes incorporate. Information Classification: GENERAL 20
Good Governance Practices Proxy based on client feedback ESG CONTROVERSIES ESG RATINGS Key areas of good SOCIAL PILLAR GOVERNANCE Board HUMAN RIGHTS Corporate Pay governance LABOR RIGHTS & AND COMMUNITY CUSTOMERS GOVERNANCE IMPACT SUPPLY CHAIN Governance Ownership Accounting practices Impact on Local Communities Child Labor Product Safety & Quality Bribery & Fraud Business Ethics • Sound Human Rights Collective Anticompetitive Controversial Corporate Anti-competitive Practices Bargaining & Corruption & Instability management Concerns Unions Practices Investments Behavior Financial System Instability Tax Transparency structures Civil Liberties Discrimination & Workforce Customer Relations Governance Structures Diversity Labor Management • Employee relations Labor Human Health & Safety Marketing & Human Capital Development • Staff remuneration Other Management Relations Advertising Other Capital Supply Chain Labor Standards • Tax compliance Supply Chain Labor Standards Privacy & Data Security Not covered Depending on industries’ material by UNGC risks, Labor Management or HCD Health & Safety Other screen may not be incorporated Other Information Classification: GENERAL
Mapping MSCI ESG Indexes to the Article 6, 8, and 9 key distinctions COMPARING MSCI ESG INDEXES AGAINST THE IDENTIFIED SET OF INDICATIVE MEASUREMENT PARAMETERS Information Classification: GENERAL
Details on approach to comparing MSCI ESG Indexes based on client feedback explained in previous sections E, S AND G CONSIDERATIONS IN METHODOLOGY Does it take into consideration Art. 6/8/9 key distinctions? Governance Article 6 Key Article 8 Key Article 9 Key Index Environment Data Inputs Social Data Inputs Data Inputs Distinctions Distinctions Distinctions • Values-based • Controversy • Climate exclusions E/S ❑ Sustainable Objective SRI exclusions exclusion • Controversy exclusion E/S Characteristics ❑ DNSH ESG Leaders • Controversy exclusion • Ratings • Ratings exclusion & Safeguards ❑ DNSH ❖ PASI ESG Focus • Ratings exclusion & exclusion & selection Good Governance Good Governance selection selection The ESG inputs to the methodologies are Indicates whether the methodology inputs listed under their respective columns as per appear to be consistent with key distinctions of MSCI ESG Research classification of what Article 6/8/9 based on assumptions/ proxies. constitutes as E, S, and G, while distinguishing DNSH is crossed off for methodologies that do between exclusion or selection. not incorporate inputs that are associated with “making sustainable investments”, while PASI is not incorporated in the analysis. Note: For the descriptions of key concepts referenced, please refer to Slide 25. The information is provided “as is” and does not constitute legal advice or binding interpretations of the SFDR. MSCI’s proposed approach to the key SFDR distinctions are based on assumptions and client feedback as explained in this deck. Any designations of your Article 6, 8, and/or 9 products and interpretations of key SFDR distinctions/ terms are the responsibility of financial market participants and should be discussed with your own legal counsel and your national competent authority as needed. Information Classification: GENERAL
Comparing MSCI ESG indexes using the framework based on client feedback explained in previous sections E, S AND G CONSIDERATIONS IN METHODOLOGY Does it take into consideration Art. 6/8/9 key distinctions? Governance Article 6 Key Article 8 Key Article 9 Key Index Environment Data Inputs Social Data Inputs Data Inputs Distinctions Distinctions Distinctions • Controversy • Climate exclusions • Values exclusions E/S ❑ Sustainable Objective SRI exclusion • Controversy exclusion • Controversy exclusion E/S Characteristics ❑ DNSH ESG Leaders • Ratings • Ratings exclusion & • Ratings exclusion & Safeguards ❑ DNSH ❖ PASI ESG Focus exclusion & selection selection Good Governance Good Governance selection • Climate exclusions & selection E/S Sustainable Objective • Carbon reduction Climate Paris • Values exclusions • Controversy E/S Characteristics DNSH • Controversy exclusion Aligned • Controversy exclusion exclusion Safeguards DNSH ❖ PASI • Self-Decarbonization Good Governance Good Governance • Clean tech overweight • 1.5˚C Alignment ❑ E/S ❑ Sustainable Objective Ex- • Values exclusion E/S Characteristics ❑ DNSH Controversial n/a (Controversial n/a Safeguards ❑ DNSH ❖ PASI Weapons Weapons) ❑ Good Governance ❑ Good Governance ❖ At present, Principal Adverse Impact Indicators (PASI) are not taken into consideration in the analysis given lack of clearer guidance ❑ DNSH only applies if an Article 8 product is making sustainable investments, while it applies for all Article 9 products For the descriptions of key concepts referenced, please refer to Slide 25. The information is provided “as is” and does not constitute legal advice or binding interpretations of the SFDR. MSCI’s proposed approach to the key SFDR distinctions are based on assumptions and client feedback as explained in this deck. Any designations of your Article 6, 8, and/or 9 products and interpretations of key SFDR distinctions/ terms are the responsibility of financial market participants and should be discussed with your own legal counsel and your national competent authority as needed. Information Classification: GENERAL
Key concepts based on ESA’s Final Report on the draft RTS • Environmental or social safeguards: “As regards investments that do not qualify as sustainable or as contributing to the environmental or social characteristics promoted by the financial product, financial market participants may decide to apply some baseline environmental or social safeguards such as those referred to in Regulation (EU) 2020/852.” (Final Report on the draft RTS, page 16) • Environmental or social characteristics (applies to Article 8 / “light green” products): “Financial products that promote, among other characteristics, environmental or social characteristics, or a combination of those characteristics (environmental or social characteristics) cover various investment approaches and strategies, from best-in-class to specific sectoral exclusions.” (Final Report on the draft RTS, page 15) • Sustainable investment objective (applies to Article 9 / “dark green” products): Financial products that follow Article 2(17) definition of sustainable investment of the EU SFDR • Good governance practices: As per the Final Report on the draft RTS, the definition for good governance should follow Article 2(17) of the EU SFDR – “in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance” • DNSH: “DNSH reporting must also show whether the investments are aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.“ (Final Report on the draft RTS, page 9) Information Classification: GENERAL
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